Summary

Franchise revenue and increased unit sales at Pie Five locations padding top line sales for Pizza Inn Holdings going forward.

Pizza restaurant chain Pizza Inn Holdings (PZZI) has struggled over the years with its Pizza Inn brand. However, a new fast casual brand named Pie Five has launched and is rapidly expanding. With the new brand, I believe Pizza Inn Holdings shares are undervalued.

Pie Five Expansion

In the last six months, Pizza Inn Holdings has seen demand for its Pie Five brand pick up. Here is a look at the recent franchise deals signed:

November 11th: Signed a 10-unit deal in Tennessee. The first location is scheduled to open in Tennessee in late 2014. The franchises come from an entrepreneur who has had success opening Schlotzsky's locations.

December 10th: Signed a huge deal of up to 38 units to ALC Hospitality. The deal will bring Pie Five locations to the Beltway states of Virginia, Maryland and Washington D.C. The first location recently opened in Virginia in May. The group has had success with Houlihan's franchises.

April 2nd: Announced signing in Oklahoma of Pie Five. Former NFL player Billy Bajema teamed up with a group of restaurant entrepreneurs that is involved with Firehouse Subs.

April 24th: Announced launch in St. Louis of Pie Five brand. First location will open in fall of 2014. Deal included up to 20 Pie Five locations in a territory that includes portions of Missouri and Illinois.

As of the end of the third quarter, there were 20 Pie Five locations open. The locations include:

· Texas (13)

· Kansas (2)

· Utah (2)

· North Carolina (1)

· Florida (1)

· Virginia (1)

Even with the existing franchise deals signed, Pie Five only has territory sold in 13 of the 50 states. There is now 170 locations under contract to open in the next few years. Here are states that have deals for Pie Fives:

· Florida

· Illinois

· Kansas

· Maryland

· Missouri

· Nebraska

· North Carolina

· Oklahoma

· Tennessee

· Texas

· Utah

· Virginia

· Washington D.C.

Pie Five 2014 Expansion

In fiscal 2013, the company opened four franchised Pie Five locations and an additional four company-owned locations. At the end of the third quarter, there was 13 company-owned locations and 7 franchised locations. The company now expects to double the number of Pie Five locations by the end of calendar 2014.

The growth and sales of the brand has been outstanding. Not only did company-owned locations see weekly sales increase 16.9%, but the eight newest stores saw huge growth as well. The eight newest stores (4 franchised, 4 company owned) saw sales that were 45% higher than the existing 11 stores.

The important thing for investors to remember is that franchise fees paid to the company are recognized as stores open. The 20th location that just opened in Richmond, Virginia will be recorded in the third quarter. Here is a look at the new pricing model (from annual report 2013) for franchised brands under the Pizza Inn Holdings umbrella of brands:

Pizza Inn Buffet

Pizza Inn Delco

Pizza Inn Express

Pie Five

Development Fee

NA

NA

NA

$5,000

Franchise Fee

$25,000

$10,000

$5,000

$20,000

Franchise Term

20 years

10 years

5 years

10 years

Renewal Period

10 years

10 years

5 years

5 years

Royalty Rate

4%

4%

5%

6%

National Advertising Rate

1%

1%

NA

2%

Required Total Advertising Rate

5%

5%

3.5%

5%

Click to enlarge

As you can see, the franchise fees are much higher for Pie Five locations. Each Pie Five that opens gets $25,000 for Pizza Inn Holdings. The Pie Five locations also pay a higher royalty rate to the parent company.

My Financial Thoughts

Pizza Inn plans on opening 20 Pie Five stores by the end of 2014, based on the fact it will double its current count. I predict that 15 of these will be franchise locations, which are already baked into the backlog of stores, and 5 company-owned locations, possibly in states that already have Pizza Inn locations but no signed franchise agreements to establish a presence.

Fifteen franchises opened by the end of 2014 would net $375,000 in franchise and development fees. The average weekly sales at Pie Five (reported at the end of the last fiscal year) are $11,372, good for annual sales of $591,344. This number seems extremely conservative with recent third-quarter earnings, but we will use to be safe. A 6% royalty on the franchised stores with average sales would bring in $532,210. The annual average would also bring in $2.96 million in sales from the five company-owned locations opened.

These estimates would bring a conservative $3.87 million to the top line for sales for Pie Five and parent Pizza Inn Holdings. This isn't a huge number, but considerable for a company that had $41.9 million in sales in the last fiscal year and a market capitalization of $55 million. Keep in mind these estimates are conservative concerning unit sales, but are also based on 20 additional locations opened. With a backlog of 170 locations, you can also see how strong unit growth can rapidly expand sales to the top line.

Third-Quarter Earnings

Pizza Inn Holdings recently reported third-quarter earnings. The company saw total sales grow to $10.9 million, which was growth of 11%. Adjusted EBITDA was a reported loss of $0.2 million. The company reported a net loss of $0.1 million, an improvement from the prior year.

Impressive growth from the company's brands was mostly ignored by Wall Street. The company reported company owned Pie Five locations saw weekly sales grow 16.9%. In the last fiscal year, Pie Five had annual sales of $4.8 million based on an average of 8 units open throughout the year. In last year's fourth quarter, Pizza Inn Holdings had sales of $11.1 million. I believe that sales will exceed that number thanks to strong comparable sales and the opening of additional units. Here is how the first three quarters have fared:

· 1st-quarter sales: $10.2 million

· 2nd-quarter sales: $10.2 million

· 3rd-quarter sales: $10.9 million

· Nine-Month Sales: $31.3 million

Fourth-quarter sales comparable to last year's $11.1 million would still represent growth of 1%. However, a gain of 11% like in the third quarter would produce fourth-quarter sales of $12.3 million. This would bring annual sales to $43.6 million, representing growth of 4%. I believe that number is also conservative considering the additional franchise revenue coming in the fourth quarter with several stores opening.

Competition and Growth of Fast Casual Pizza

Pizza Inn is not alone in bringing fast casual pizza to the masses. This might explain the reason investors aren't as optimistic towards Pizza Inn Holdings. I have wrote about large chains Buffalo Wild Wings (NASDAQ:BWLD) and Chipotle (NYSE:CMG) bringing their respective PizzaRev and Pizzeria Locale chains to the masses. This Franchise Chatter article also highlights the competition from chains like Uncle Maddio's, YourPie, and Blaze Pizza as well. Here is a look at how those chains are fairing:

· PizzaRev plans on having 65 locations by 2015 and with the financial backing and minority stake from Buffalo Wild Wings, it might be able to rapidly expand nationally.

· Blaze Pizza had 10 stores open in 2013 and plans on having 45 locations open by the end of 2014. The chain also has 230 stores in the pipeline. Of course, it helps that the founders of Wetzel's Pretzels are behind this brand and have history with a franchising model and expanding from regional to national.

· YourPie plans on having 100 stores open in 2 years.

While there is amble competition for Pie Five to fend off, the fast casual pizza market is growing and has plenty of room for several competitors. Franchise Chatter highlighted the market with this, "Fast casual custom pizza evolved into the hottest franchise concept of 2014." The article also said the fast casual pizza market has "staying power" and isn't a food fad. An industry expert from Technomic had this to say, "We expect to see a lot of opportunity for growth in the next five to eight years. It will likely attract more franchises and other investors to come into the market as it's still in the very early stage."

Pizza Inn Brand

Pizza Inn is still not a national brand, with a strong presence in the south and room to improve across the country. Here are the states Pizza Inn has locations in:

· Alabama

· Arkansas

· Georgia

· Illinois

· Kentucky

· Louisiana

· Mississippi

· Missouri

· New Mexico

· North Carolina

· Oklahoma

· South Carolina

· South Dakota

· Tennessee

· Texas

· Virginia

Even with the focus on growing out Pie Five, the growth of Pizza Inn is not dead. In fact, Pizza Inn is using the Express concept and smaller format stores to grow the unit count of this brand. Expansion into other states could be possible very soon.

Conclusion

Pizza Inn has traded with negative profit margins for several years, with underperforming restaurants and high costs. The company is now closing underperforming Pizza Inn locations. That process, along with the growth of higher margin Pie Five locations, should greatly improve operating margins going forward.

I believe the fourth quarter could be the turning point for shares. A strong earnings report is likely, with improving operation metrics, more Pie Five stores open to help pad company sales and franchise revenue, more opening revenue recognized from new Pie Fives, and the improving margins from the closing of underperforming stores.

Pizza Inn will likely not give guidance for the next fiscal year, but I believe it is the year that everything will come together. My conservative estimates above show almost $4 million extra hitting the top line just from new Pie Five locations. Most of that revenue should trickle down to the bottom line, as it represents franchise fees and royalties. If the company-owned locations can keep up the strong growth they have seen, the estimates will be way under actual results.

The thinly covered press releases announcing Pie Five openings or signings haven't caused the stock to jump. It appears that investors are waiting to see the brand succeed and help bring the company to a profit. The third-quarter results showed that this is a company on the verge of a profit. I believe the company could post positive earnings per share in the fourth quarter, which should give shares a boost.

Shares of Pizza Inn Holdings trade in the middle of their 52-week range at $6.38. In 2014, shares are down 22% after once rising on the success of the Pie Five brand. The additional restaurants signed in 2014 and the stellar third-quarter earnings should have led shares to rebound, but investors continue to ignore the possibilities of the company.

I believe shares are extremely undervalued as a believer in the Pie Five brand. This is a brand that could expand nationally and is in the hottest food and franchise sector. Even with competition, Pie Five could grow to 300 to 400 units in seven years. The time to get behind Pizza Inn Holdings is now.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PZZI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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